We are now entering the second part of the book, the application of the one sentence economic lesson. Part 2 has 22 chapters. We will skip the 2nd chapter for I made a revision of it here (This hyperlink will work once my site is up. It was written in Filipino. You can read it in English using the Google Translate at the bottom of the page).
Chapter 3 is all about the fallacy of thinking that war is advantageous to the economy. This is why understanding Chapter 2, the parable of broken window is necessary to grasp the real nature of this economic fallacy. The so-called advantage of war, which is the "increase" in demand is actually a "diversion of demand". Hazlitt explains this "benefit":
"The destruction of houses and cities will make more business for the building and construction industries. The inability to produce automobiles, radios, and refrigerators during the war will bring about a cumulative post-war demand for those particular products...But when they build more houses they will have just that much less manpower and productive capacity left over for everything else. When they buy houses they will have just that much less purchasing power for everything else. Wherever business is increased in one direction, it must...be correspondingly reduced in another" (p. 15).
An important factor in this subtle "increase" in demand is made possible through the printing of money. As the salary of people increases due to additional money supply, people will think that they are better off and this will make an impression that more demand has been created. Hazlitt elaborates the impact of the increase in money supply:
"...printing money is the world's biggest industry...But the more money is turned out in this way, the more the value of any given unit of money falls. This falling value can be measured in rising prices of commodities. But as most people are so firmly in the habit of thinking of their wealth and income in terms of money, they consider themselves better off as these monetary totals rise, in spite of the fact that in terms of things they may have less and buy less" (pp. 14-15).
"...the mere issuance of more money, with the consequence of higher wages and prices - may look like the creation of more demand. But in terms of the actual production and exchange of real things it is not" (p.17).
Personal Remark
In the second chapter of the book, two subordinate economic fallacies are exposed under the main economic fallacy of thinking that war is advantageous. These are the fallacy of thinking that war creates increase in demand and the fallacy of thinking that demand is created through the increase in money supply. Without analyzing the sequence of economic actions prior to and after the destruction caused by war, identifying these fallacies is really difficult.
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